Demergers in brief
Group demergers:
CGT and dividend
tax relief
June 2003
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What is a
demerger?
The government has removed tax impediments for businesses that
restructure by demerging one or more subsidiaries, where the demerger
is for commercial reasons.
For shareholders or unitholders of a group that demerges:
– CGT and dividend tax relief may now be available for demergers from
1 July 2002, and
– If you later sell your interests, you will need to adjust the cost base of
your interests when working out capital gains or losses.
A demerger is a form of restructure in which investors in the head entity (for example,
shareholders or unitholders) gain direct ownership in an entity that they formerly owned
indirectly (the ‘demerged entity’). Underlying ownership of the companies and/or trusts
that formed part of the group does not change.The company or trust that ceases to own
the entity is known as the ‘demerging entity’.
Before demerger
After demerger
Shareholders
Shareholders
Head Company
(Demerging Entity)
100%
Company A
Head Company
(Demerging Entity)
Head Company
demerges
Company A
shares to its
Shareholders
100%
Company A
(Demerged Entity)
There are three ways to demerge, which can be used alone or in combination:
ownership interests (for example, shares or units) in the demerged entity are disposed
of to owners of the head entity
ownership interests in the demerged entity are cancelled and new interests in that
entity are issued to owners of the head entity
the demerged entity issues sufficient new interests in itself to owners of the head entity
so as to bring about an effective transfer (this is often referred to as swamping).
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What demergers
qualify for
tax relief?
To qualify for tax relief:
there must be a demerger group
the group must undergo a demerger that satisfies the demerger tests, and
the demerger must occur on or after 1 July 2002.
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Demerger group
A demerger group consists of a head entity and one or more entities known
as ‘demerger subsidiaries’.The group can comprise companies and/or fixed trusts.
A discretionary trust cannot be a member of a demerger groups; however, it may be
one of the owners of the head entity.
The head entity of a demerger group is a company or fixed trust at the top of the group
structure. No other entity in the group can have ownership interests in the head entity.
However, where the head entity owns more than 20% and less than 80% of a listed company
or widely held trust, the listed company or widely held trust can choose for the head entity
not to be a member of the demerger group. In this case, the listed company or widely held
trust would usually become the head entity.
A demerger subsidiary is a company or fixed trust in which members of the demerger
group, either alone or with other members in the demerger group, own or have the right
to acquire ownership interests of more than 20% of that entity (generally measured
by rights to income or capital, and voting rights).
Demerger group consists of:
– Head Company
– Company A
– Fixed Trust
– Company B
Demerger group
Shareholders
Head Company
100%
Company C is not a member of the
demerger group.
100%
Company A
Fixed Trust
50%
50%
Note: although Fixed Trust is a member of the
demerger group, it cannot be demerged (see
same entity type test below). Head Company can
demerge either Company A or Company B.
Company B
10%
Company C
Demerger that satisfies demerger tests
To qualify for tax relief, there are a number of basic tests that need to be satisfied:
80% test
nothing else test
same entity type test
maintenance of ownership test
residency test
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Other eligibility requirements may apply to certain demergers.
80% test
Under the 80% test, the demerger group must effectively cease to own at least 80% of the
interests it holds in the demerged entity. As noted above, this can occur by disposal of
interests, interests ending, swamping, or a combination of methods.
Before demerger
After demerger
Other
Shareholders
Shareholder 1
10%
10%
90%
90%
Head
Company
Head
Company
8%
100%
Must demerge 80%
or more of interest
Other
Shareholders
Shareholder 1
20%
Company A
Company A
Note: Head Company demerges 80% of its interests in Company A and retains 20%.
2
72%
Nothing else test
Under the restructure the owners of the head entity must acquire a new interest in the
demerged entity and nothing else (for example, they cannot also receive cash).The mere
existence of a sale facility for new or original interests will not normally breach this rule.
Same entity type test
Under the same entity type test, the new interests must be in the same kind of entity as
the original interests. For example, demerging a fixed trust to unitholders of a fixed trust
would satisfy the test. Demerging shares in a company to unitholders of a fixed trust
would not satisfy the test.
Maintenance of ownership test
The maintenance of ownership test requires that, after the demerger:
each owner of the head entity must own the same proportion of new interests
in the demerged entity as they previously owned in the head entity (ignoring any other
direct interests they hold in the demerged entity), and
each owner must have the same proportionate total market value of ownership
interest in the head entity and in the demerged entity as they owned in the head entity
before the demerger. Market value can be a reasonable approximation and can be
anticipated by the head entity before the demerger.
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In working out whether the proportional ownership tests have been satisfied, the following
types of interests may be ignored:
certain qualifying partly paid shares or rights acquired under an employee share scheme
if they total no more than 3% of the ownership interests in the head entity, and
certain adjusting instruments in listed entities (for example, reset preference shares
or convertible notes) if they total no more than 10% of the ownership interests in the
head entity.
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Residency test
This test is only relevant if there are non-resident owners of the head entity.
To pass the residency test, more than half of the original interests in the head entity have
to be owned by Australian residents, or owned by non-residents whose new interests
have the necessary connection with Australia just after they acquire them.
Non-Resident Shareholders
Demerge
100%
Interest
US Co
(Head Entity)
100%
Aus Pty Ltd
Non-Resident Shareholders
US Co
(Head Entity)
Residency requirements
for demerger NOT satisfied
(New interests DO NOT
have necessary connection
with Australia)
100%
Demerge
100%
Interest
100%
Aus Pty Ltd
Residency requirements
for demerger satisfied
(New interests DO have
necessary connection
with Australia)
100%
US Sub
US Sub
There are additional residency requirements that must be satisfied by an owner of the
head entity who wants to claim rollover relief.
What is not a demerger?
The following do not qualify for the demerger relief:
share buy-backs, that is, off-market purchases under Div 16K of Part III of the Income Tax
Assessment Act 1936, and
situations where any owner of the head entity can get rollover relief for all CGT events
that happen to their ownership interests under the demerger from other provisions of
the tax law.
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What tax
relief does the
measure provide?
If the demerger tests are satisfied, there are tax consequences for:
members of the demerger group, and
the owners of the head entity.
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Tax consequences
for members of the
demerger group
There are three possible consequences for the demerger group if it undertakes an
eligible demerger:
capital gains or capital losses are disregarded if they arise under the following
CGT events happening to the group’s interests in the demerged entity:
• disposal (CGT event A1)
• cancellation (CGT event C2)
• ending of an option to acquire a share (CGT event C3), or
• capital gain made on certain pre-CGT shares or trust interests (CGT event K6).
CGT event J1 (company stops being a member of a wholly owned group after rollover)
does not happen to any member of the demerger group, and
certain adjustments are required to be made to capital losses or the reduced cost
base of assets retained in the group where the market value of those assets has fallen
because of the demerger (that is, where the effect of the demerger is to shift value
out of those assets).
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No other cost base adjustments
If the cost bases have been adjusted under the demerger provisions, no other adjustments
are to be made as a result of the demerger (for example, under the general value
shifting rules).
Tax consequences
for owners of the
head entity
There are four possible consequences for the owners of interests in the head entity:
optional CGT rollover
cost base adjustments
access to the CGT discount, and
dividend relief.
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Optional CGT rollover
An owner of interests in the head entity may choose rollover relief for CGT events that
happen to their interests under the demerger (for example, a capital payment in respect
of their shares by the company – CGT event G1).
This choice is available to a resident, or to a non-resident whose new interests in the
demerged entity have the necessary connection with Australia.
If an owner of interests in the head entity chooses rollover relief:
they disregard any capital gain or capital loss made on any CGT event happening to
their original interest in the head entity
if they owned any pre-CGT interests in the head entity, a corresponding number
of new interests in the demerged entity are treated as pre-CGT interests, and
if any of their interests in the head entity are cancelled, both pre-CGT interests and
post-CGT interests are cancelled proportionately.
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Example 1: Proportion of pre-CGT interests
Before the demerger, you had 200 shares in Head Company and 60 of those shares are pre-CGT.
The proportion of your shares that are pre-CGT shares is 30% (60/200). Under the demerger you
receive 40 shares in Company A — 12 of those shares will be taken to be pre-CGT (30% of 40).
Example 2: Original interests cancelled
Before the demerger, you had 200 shares in Head Company and 60 of those shares are pre-CGT.
Under the demerger, 80 of your shares in Head Company are cancelled. The proportion of your
shares being cancelled is 40% (80/200).
Under the demerger, 56 of your post-CGT shares (40% of 140) and 24 of your pre-CGT shares
(40% of 60) will be taken to have been cancelled.
If an owner of interests in the head entity does not choose rollover, any capital gain
or capital loss is taken into account in working out their net capital gain or capital loss
amount for the year and none of the new interests in the demerged entity will have
pre-CGT status.
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Cost base adjustments must be made by owners of interests in
the head entity
After receiving new interests in the demerged entity under a demerger, the owners
must make cost base adjustments to both their interests in the head entity and their
new interests in the demerged entity. This applies irrespective of whether rollover
is chosen.
Broadly, this involves apportioning the total unindexed cost bases of their interests in
the head entity over the remaining original interests in the head entity and the new
interests in the demerged entity. Only post-CGT interests are taken into account.
The apportionment must be reasonable by reference to the relative market values
of the new and original interests.The head entity or the demerging entity will advise
the owners of interests of these proportions.
If the cost bases have been adjusted under the demerger provisions, no other adjustments
are to be made as a result of the demerger (for example, under the general value
shifting rules).
Use the adjusted cost bases for any later CGT event that happens to those interests,
for example, on a later sale of these shares.
Example 3
Immediately before the demerger you have 100 post-CGT shares in Head Company. The total cost base
(ignoring indexation) is $700.
Under the demerger, you receive the 20 shares in Company A and retain your Head Company shares.
Just after the demerger, the market value of all of Company A shares is $165 and market value of
all of the Head Company shares is $935.
Your total cost base of $700 will be apportioned 85% (935/1100) to Head Company shares and 15%
(165/1100) to Company A shares.
The new cost base for each of your Head Company shares will now be $5.95 (85% of $700 divided
by 100). The new cost base for each of your Company A shares will now be $5.25 (15% of $700
divided by 20).
Acquisition date for CGT discount purposes
If there is a CGT event under the demerger, the owners of interests in the head entity
will be entitled to claim the CGT discount for their new interests in the demerged entity.
They must have owned their original interests for more than 12 months.
Example
You bought shares in Head Company on 1 October 1997. Under a demerger, there is a return of capital
and you receive new shares in Company A on 1 May 2003. For CGT discount purposes, you are treated
as satisfying the 12 month ownership test for your shares in Company A on 1 October 1997.
Dividend relief
A dividend paid under the demerger will generally not be subject to tax, if at least 50%
of the CGT assets (by market value) owned by the demerged entity or its demerger
subsidiaries are used in the carrying on of a business by the demerged entity or its
demerger subsidiaries.This concession is automatic unless the head entity elects that
the dividend concession not apply.
Dividend relief subject to an integrity measure
The dividend relief contains an integrity provision that limits the relief to genuine
demergers. It is broadly designed to ensure that there is an appropriate mix of capital
and profit distributed to shareholders under the demerger.
The Tax Office may determine that the whole or part of a distribution is not a demerger
dividend.The consequence is that the dividend paid under the demerger will no longer be
eligible for dividend relief and will be taxable as an ordinary dividend.The non-dividend
component of the distribution made under the demerger may also be reviewed to ascertain
whether it includes a disguised dividend.The head entity may seek advice from the
Tax Office on the application of these provisions.
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Legislative references
The Demergers measure is contained in New Business Tax Systems (Consolidations,Value
Shifting, Demergers and Other Measures) Act 2002. This Act:
introduces Division 125 into the Income Tax Assessment Act 1997
amends certain dividend provisions in the Income Tax Assessment Act 1936
(principally section 44 and 45B), and
contains a number of other consequential and transitional provisions.
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Further information
If you need more information about demergers, you can:
phone 13 24 78
obtain A Fax from Tax on 13 28 60
visit our website at www.ato.gov.au (type in ‘demerger’ in the search function)
write to us at GPO Box 9990 in your capital city
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Disclaimer and guarantee
The information in this publication is current at June 2003 and we have made every effort to ensure it is accurate.
However, if something in the publication is wrong or misleading and you make a mistake as a result, you will not be charged
a penalty.You may have to pay interest, depending on the circumstances of your case. If you feel this publication does not
fully cover your circumstances, please seek help from the Tax Office or a professional tax adviser. Since we regularly revise
our publications to take account of any changes to the law, you should make sure this edition is the latest.The easiest way
to do this is by checking for a more recent version on our website at www.ato.gov.au
Copyright
© Commonwealth of Australia 2003
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NAT 8078-05.2003
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